SECURITIES AND EXCHANGE COMMISSION
(Release No. 35-27844; 70- 10205)
Order Authorizing Amendments to Governance Documents and Termination of Shareholder Rights Plan
May 5, 2004
FirstEnergy Corp. ("FirstEnergy"), Akron, Ohio, a registered holding company under the Public Utility Holding Company Act of 1935, as amended ("Act") has filed with the Securities and Exchange Commission ("Commission") a declaration ("Declaration") under sections 6(a)(2), 7, and 12(e) of the Act and rules 54, 62 and 65 under the Act. A notice of the Declaration was issued on March 26, 2004 (Holding Company Act Release No. 27823).
FirstEnergy requests authority to: (1) amend its Amended Articles of Incorporation ("Articles") and Amended Code of Regulations ("Regulations," and together with the Articles, "Governing Documents") to eliminate or modify certain so-called "anti-takeover" type provisions that were originally intended, at least in part, to force persons seeking to take control of FirstEnergy to initiate arm's length discussions with the Board of Directors; and (2) terminate its shareholder rights plan.
By order dated March 26, 2004 (Holding Company Act Release No. 27823) FirstEnergy was authorized to solicit proxies ("Solicitation") from its common shareholders for use at its annual meeting scheduled for May 18, 2004, and at any adjournment(s), in connection with the proposed amendments to the Governing Documents.1 The termination of the shareholder rights plan does not require the consent of the shareholders.
I. Requested Authority
A. Amendments to Governing Documents
FirstEnergy proposes to amend its Governing Documents to declassify its Board of Directors and eliminate certain supermajority shareholder voting requirements.
1. Declassification of Board of Directors
FirstEnergy's Regulations currently provide that the Board of Directors is to be divided into three classes with the members of each class serving three-year terms. The Board currently consists of fifteen members divided into three classes. The Board of Directors has unanimously adopted resolutions, subject to shareholder and regulatory approvals, amending the Regulations to eliminate the classification of Board members. The proposal would allow for the annual election of directors beginning with the director slate to be voted upon at FirstEnergy's 2005 annual meeting. Directors who have been previously elected for three-year terms expiring beyond the 2005 annual meeting would serve out the balance of their three-year term so that no director previously elected to a multi-year term would have his or her term shortened. Consequently, under the proposed amendments, the first class of directors to be elected to one-year terms would be in 2005. Directors standing for election in 2006 and 2007 would likewise be elected to one-year terms so that upon the conclusion of the annual meeting in 2007, the declassification of the Board would be complete and all directors would be subject to annual elections.
FirstEnergy states that a shareholder proposal to declassify the Board of Directors has been received by FirstEnergy and included in its proxy material each year since 1998. Each year, the Board of Directors has considered carefully the advantages and disadvantages of maintaining a classified board. FirstEnergy indicates that while the Board of Directors still believes that there are compelling reasons to maintain a classified board, in furtherance of its goal of ensuring sound corporate governance policies, after further consideration of the various arguments for and against a classified board, and in light of the amount of shareholder support for a similar proposal at the 2003 annual meeting, the Board has decided to propose declassifying the board. Approval of the proposal requires the affirmative vote of the holders of at least 80% of the voting power of FirstEnergy, voting as a single class.
2. Elimination of Certain Supermajority Voting Rights
FirstEnergy indicates that it will ask its shareholders to consider and vote upon a proposal to amend regulation 36 of the Regulations and to repeal Article X of the Articles, which relate to the voting requirements for amending or repealing certain provisions in the Governing Documents.
Currently, the affirmative vote of 80% of the shares entitled to vote, voting as a single class (together, "80% Supermajority") is required to make certain amendments to the Governing Documents. FirstEnergy's Board of Directors is proposing that the 80% Supermajority voting requirements be changed in the Governing Documents to reduce the voting requirements to two-thirds, which is consistent with Ohio law. Approval of this proposal requires the affirmative vote of 80% of the shares entitled to vote.
Article X of the Articles establishes an 80% Supermajority requirement to amend or repeal the following provisions: (1) article V-the fixing or changing of the terms of unissued or treasury shares; (2) article VI-the absence of cumulative voting rights in the election of directors; (3) article VII-the absence of preemptive rights to acquire unissued shares; and (4) article VIII-the ability of FirstEnergy to repurchase its shares. Similarly, regulation 36 of the Regulations also establishes an 80% Supermajority requirement to amend or repeal the following provisions: (1) regulation 1-the time and place of shareholder meetings; (2) regulation 3(a)-the calling of special shareholder meetings; (3) regulation 9-the order of business at shareholder meetings; (4) regulation 11-the number, election and term of directors; (5) regulation 12-the manner of filling vacancies on the Board of Directors; (6) regulation 13-the removal of directors; (7) regulation 14-the nomination of directors and elections; and (8) regulation 31-the indemnification of directors and officers. Both article X and regulation 36 require an 80% Supermajority vote to be amended or repealed.
In addition, FirstEnergy's Board of Directors proposes to change the voting requirement in regulations 11 and 13. Currently, regulation 11 enables a change in the number of Directors of FirstEnergy and regulation 13 provides that any Director, or the entire Board, may be removed, in each case only by an 80% Supermajority vote. The Board of Directors proposes to reduce this in both cases to two-thirds.
FirstEnergy states that, while these protective measures are beneficial, the Board believes there are also compelling arguments for having a lower threshold for shareholder amendments to the Governing Documents. For example, in recent years some investors have expressed the view that a lower threshold for shareholder amendments in the Governing Documents may improve the corporate governance profile of FirstEnergy, in that it allows increased flexibility in responding to unforeseen challenges and increases shareholders' ability to effectively participate in corporate governance.
FirstEnergy indicates that similar amendments seeking to remove the 80% Supermajority voting requirement from the Regulations and the Articles have been proposed by FirstEnergy's shareholders in the past and have received support at Annual Meetings. Given the amount of shareholder support for the proposal and following careful assessment, FirstEnergy states that the Board of Directors has decided to propose the elimination of the 80% Supermajority voting requirement.
B. Termination of Shareholder Rights Plan
In November 1997, the Board of Directors of FirstEnergy authorized assignment of one share purchase right ("Right") for each outstanding share of FirstEnergy common stock. The Rights are issued under Rights Agreement dated as of November 18, 1997 between FirstEnergy and The Bank of New York, as rights agent, ("Rights Agreement") which was approved by the Commission on June 30, 2003 (Holding Company Act Release No. 27694). Each Right entitles the registered holder of the associated share of common stock to purchase from FirstEnergy one share of common stock at a price of $70 per share ("Purchase Price") when the rights become exercisable. The Rights, which currently expire on November 18, 2007, are not exercisable until a triggering event involving either an acquisition of 15% or more of the outstanding common stock of FirstEnergy by any person or group of associated persons ("Acquiring Person") or the commencement or announcement of an intention to make a tender offer by any Acquiring Person of at least 25% of the outstanding common stock of FirstEnergy. In the event of a merger with, or other specified transaction (as described in the Rights Agreement) between FirstEnergy and an Acquiring Person, the holder of each Right would be entitled to receive, upon exercise of the Right, a number of shares of common stock of FirstEnergy or the Acquiring Person, as the case may be, having a value double the amount of the purchase price.
FirstEnergy's indicates that its Board of Directors has elected, subject to receipt of Commission authorization, to terminate the Rights Agreement through the acceleration of the expiration date of the issued Rights. FirstEnergy states that as is the case with previous shareholder proposals to declassify the Board of Directors and to eliminate the 80% Supermajority voting requirements, the Board of Directors has considered carefully the advantages and disadvantages of the Rights Agreement, and that while the Board of Directors still believes that there are compelling reasons to maintain the Rights Agreement, in furtherance of its goal of ensuring sound corporate governance policies, after further consideration of the various arguments for and against rights plans in general, and in light of the amount of shareholder support for a similar proposal at the 2003 annual meeting, the Board has taken action to accelerate the expiration date of the outstanding Rights to March 31, 2004, or a later date as the Commission issues an order. FirstEnergy indicates that no shareholder approval is needed to terminate the Rights Agreement.
II. Rule 54 Analysis
The proposed transactions are subject to the requirements of rules 53 and 54 under the Act. Under rule 53(a), the Commission shall not make certain specified findings under sections 7 and 12 in connection with a proposal by a holding company to issue securities for the purpose of acquiring the securities of, or other interest in, an exempt wholesale generator ("EWG"), or to guarantee the securities of an EWG, if each of the conditions in paragraphs (a)(1) through (a)(4) of rule 53 are met, provided that none of the conditions specified in paragraphs (b)(1) through (b)(3) of rule 53 exists. Rule 54 provides that the Commission shall not consider the effect of the capitalization or earnings of subsidiaries of a registered holding company that are EWGs or foreign utility companies ("FUCOs") in determining whether to approve other transactions if rule 53 (a), (b) and (c) are satisfied.
FirstEnergy currently meets all of the conditions of rule 53(a), except for clause (1). By order dated October 29, 2001 (Holding Company Act Release No. 27459) ("Merger Order"),2 as modified by order dated June 30, 2003 (Holding Company Act Release No. 27694) ("June 2003 Order"), the Commission, among other things, authorized FirstEnergy to invest in EWGs and FUCOs as long as FirstEnergy's aggregate investment, as defined in rule 53(a)(1) does not exceed $5 billion. The $5 billion amount is greater than the amount which would be permitted by rule 53(a)(1) which, based on FirstEnergy's consolidated retained earnings, as defined in rule 53(a)(1), of $1.6 billion as of December 31, 2003 would be $800 million. The Merger Order, as modified by the June 2003 Order, also specifies that this $5 billion amount may include amounts invested in EWGs and FUCOs by FirstEnergy and GPU, Inc., at the time of the Merger Order ("Current Investments") and amounts relating to possible transfers to EWGs of certain generating facilities owned by certain of FirstEnergy's operating utilities ("GenCo Investments").
Under the Merger Order, the Commission reserved jurisdiction over investment in EWGs and FUCOs, other than the Current Investments and GenCo Investments, that exceed $1.5 billion. As of December 31, 2003, and on the same basis as set forth in the Merger Order, FirstEnergy's aggregate investment in EWGs and FUCOs was approximately $1.13 billion, an amount significantly below the $5 billion amount authorized in the Merger Order. Additionally, as of December 31, 2003, consolidated retained earnings were $1.6 billion. By way of comparison, FirstEnergy's consolidated retained earnings as of December 31, 2002 were $1.52 billion.
With respect to rule 53(b), none of the circumstances enumerated in subparagraphs (1), (2) and (3) have occurred. For the reasons given above, the requirements of rule 53(c) are satisfied.
As a result, the Commission has considered the effect on the FirstEnergy system of the capitalization or earnings of any FirstEnergy subsidiary that is an EWG or FUCO in determining whether to approve the proposed transactions. Applicants state that since the date of the Merger Order, there has been no material adverse impact on FirstEnergy's consoliated capitalization resulting from its investments in EWGs and FUCOs, and the proposed transaction will not have any material impact on FirstEnergy's capitalization. As of December 31, 2003, FirstEnergy's consolidated capitalization consisted of 40.1% common equity, 1.6% cumulative preferred stock, 55.8% long-term debt and 2.5% short-term debt. As of December 31, 2001 those ratios were as follows: 30.3% common equity, 3.1% cumulative preferred stock, 63.1% long-term debt and 3.5% short-term debt. FirstEnergy maintains that its operating public-utility subsidiaries remain financially sound companies as indicated by their investment grade ratings from nationally recognized rating agencies for their senior secured debt.
Since the date of the Merger Order, FirstEnergy's investments in EWGs and FUCOs have contributed positively to its level of earnings, other than for the negative impact on earnings due to FirstEnergy's writedowns of its investments in Avon Energy Partners Holdings and GPU Empresa Distribuidora Electrica Regional S.A. Finally, since the date of the Merger Order, and, after taking into account the effects of FirstEnergy's acquisition of GPU, there has been no material change in FirstEnergy's level of earnings from EWGs and FUCOs. On February 2, 2004 FirstEnergy announced that it had completed the sale of all of its remaining operating FUCO assets.
FirstEnergy states that no state or federal commission, other than this Commission, has jurisdiction over the proposed transactions. FirstEnergy estimates that the total amount of all fees, commissions and expenses to be incurred in connection with the proposed transactions will not exceed $35,000.
Due notice of the filing of the Declaration has been given in the manner described in rule 23 under the Act, and no hearing has been requested of or ordered by the Commission. On the basis of the facts in the record, the Commission finds that the applicable standards of the Act and the rules under the Act are satisfied, and no adverse findings are necessary.
IT IS ORDERED, that under the applicable provisions of the Act and the rules under the Act, that the Declaration regarding the amendments to the Governing Documents and the termination of the shareholder rights plan is permitted to become effectively immediately, subject to the terms and conditions of rule 24 under the Act.
For the Commission, by the Division of Investment Management, pursuant to delegated authority.
Margaret H. McFarland
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